Introducing Bitcoin

What Is Bitcoin?

We live in a world where almost everything is centralized. To obtain food, most people don't go to a farm that is owned and run by a family. Instead, they usually go to a grocery store and buy food that was grown on large, corporately-owned fields in another country. The coffee that you buy was probably produced from beans grown in South America or Indonesia on a plantation owned by a large corporation. That corporation probably paid workers little amounts of money for them to work the fields. The end product of ground coffee was perhaps shipped to a centralized warehouse — say, a Folgers or Maxwell House warehouse — then distributed it to stores that are corporately owned by a central organization. If you bought the coffee at Wal-Mart, you bought it from a centralized organization that does not do commerce on a local level.

Unless you take care to make sure that the cloth used to make your clothes were obtained from a local place and then sewn by a local seamstress or tailor, your clothes were probably produced in the same way. The fibers used to create the cloth were probably grown on a large plantation in a poor part of the world, and workers were paid slave wages to tend to it. Another set of workers toiled in sweatshops, making pennies for their time and energy, to turn the fiber into fabric and then the fabric into clothes. By the time the clothes made their way to you, the consumer, and the centralized company that produces the clothes — say, Gap, Old Navy, JCPenney, or Nike — has made a tremendous profit.

Banks and other financial institutions run in a similar fashion. Money is generated by the United States government, either in the form of cash or interest rates. If the government wishes to increase the amount of money in circulation, it can either print more cash or lower interest rates. If it wishes to decrease the amount of money in circulation, it can either destroy cash or raise interest rates. Moreover, the central government can determine precisely how much the dollars that it creates are worth. It can devalue the dollar so that it loses power against other currency, or implement policies to increase the dollar's value against other currencies. Every move that it makes regarding fiscal policy directly impacts every person who uses dollars; the individuals who use the dollars have little say in what the centralized government is doing about the value of their dollars. ​

Most individuals and companies choose to keep their dollars in banks for safekeeping and growth. Those banks are again centralized locations. Some banks, like Chase and Wells Fargo, are huge conglomerations that have local branches to service customers in particular geographical areas. Other banks like local credit unions have policies designed to benefit the local economy but still are out to maintain their own bottom line. In other words, money goes to the banks so that ultimately the banks, not the individual customers can benefit. Bitcoin presents an entirely new paradigm, a shift away from the culture of centralization so that power goes back to the individual people involved in the economy rather than to entities at the center who stand to get rich. It is a form of money that is not run by a government or a bank but instead run by the individual people who use it. In other words, it is decentralized. While there is a team of developers who are adding to the Bitcoin code and protocol, they are unable to manipulate it in any way. They don’t control it and nobody controls it. It is a revolution against the control brought about by centralization. Bitcoin is a type of virtual currency, also referred to as a cryptocurrency. Virtual currencies are types of money that exist entirely in a digital form rather than as cash that can be carried around. It was originally conceived of as a peer-to-peer currency system, making it vastly different than fiat currencies that are regulated by a centralized government. It is unregulated, meaning that because national governments do not issue it, they are not able to pass laws controlling it. More than just a currency, it is a movement that has empowered people to take control of their own economics and finances without having to pay taxes or governments telling them what their money is worth and what they can and can’t do with it. Bitcoin runs on a type of technology called blockchain; blockchain was actually invented as the means by which Bitcoin would run. It ushered in a new era of computer programming in which systems can be virtually 100% hack-proof (for more information on the blockchain, see Chapter 2).

History of Bitcoin 

​Bitcoin was originally conceived by an anonymous individual (or group of individuals) who went by the pseudonym, Satoshi Nakamoto. On October 31, 2008, Nakamoto (who will from this point forward be referred to as a “he,” simply for ease of reference) released a white paper detailing the concept behind a cryptocurrency that would be upheld through a new technology known as blockchain. However, there were some important developments in the history of cybersecurity and programming that served as important precedents to his conception.

During the 1980s and especially in the 1990s, computer technology was advancing at a rapid rate, especially in the area of graphics editing. Images of models in advertisements could be airbrushed to make them appear slimmer, taller, and younger than they actually were; this phenomenon led to the legal and ethical concern of digital information being manipulated. If there was no way to prove beyond reasonable doubt that information stored on a computer had not been tampered with, then that information could not be used as evidence in a court of law. Furthermore, companies could easily manipulate the information held on their computers, which no one would be aware of. They could foreseeably backdate contracts so that certain terms could not be applied, change the dates of transactions that had occurred, and even manipulate accounting data to make the company appear to be worth more than it actually was. In early 1991, two computer programmers, W. Scott Stornetta and Stuart Haber, published an article entitled “How to Time-Stamp a Digital Document” in the Journal of Cryptology. In the article, they described a method that they had come up within which the data itself, rather than the document containing the data, would be time-stamped in a way that could not be tampered with, even by a professional third-party time-stamp service. Their idea helped form the time-stamp feature of the blockchain technology used to create Bitcoin, which helps to ensure that transactions made using the currency cannot be manipulated.

When the Internet came to prominence in the 1990s and began to revolutionize the way that business was done, security breaches that cost companies thousands, if not millions of dollars began to become almost commonplace. Hackers found ways to break into the central servers that housed all of a company's information and were able to siphon off not only large sums of money but also personal information — bank account and credit card numbers, addresses, birthdates, social security numbers — of private customers. A computer security expert at the University of Cambridge named Ross Anderson published multiple papers throughout the 1990s and into the 2000s regarding problems related to cybersecurity. He made the case that the need wasn't for tighter security protocols but for a complete change in how cybersecurity was done. The current network model in which people accessed a website by connecting to the main server which was severely inadequate. If the main server, which housed all of the company's information was hacked, the entire system would fail. The need was to move away from this network model to one that was much less susceptible to hacking.  ​

During the time that Anderson was pushing for a paradigm shift in cybersecurity protocols, a programmer named Michael Doyle created a mechanism for ensuring chain-of-evidence protocols on digital systems. Chain of evidence is important in any legal situation because a court needs to verify whether or not that evidence has been tampered with. Individuals who have handled evidence need to carefully document when they had that evidence and what they did with it. However, as with the problem of data manipulation that Haber and Stornetta proposed a solution for, there was no foolproof way to ensure that chain-of-evidence protocol had been followed with digital information. In 1998, Doyle filed for a patent for a program that would ensure that chain-of-evidence protocol was followed with digital information. His invention used a set of public and private keys, another feature that would be essential in the development of blockchain technology and Bitcoin. ​

Also in 1998, a computer programmer named Nick Szabo proposed a protocol for a digital currency program that he referred to as bit gold. Bit gold would theoretically exist in an entirely cashless state. Rather than its value being assigned artificially by the government, it would be determined by the laws of supply and demand; the number of bit gold users would determine how high the demand was, thereby giving it its value. It would employ chain-of-evidence protocols and time-stamp to ensure that the digital information through which the currency existed could not be manipulated. Bit gold users would work together to solve complex puzzles; the solutions would unlock more bit gold and become part of the next puzzle. This procedure would allow bit gold to create a peer-to-peer chain in which none of the information could be retroactively altered without every single person on the bit gold network colluding to change it. Bit gold was never implemented, but its design was so closely linked to that of Bitcoin that many have suggested Szabo could actually be the figure behind the pseudonym, Satoshi Nakamoto.

​Fast-forward 10 years, to August of 2008. Three programmers named Neal King, Vladimir Oksman, and Charles Bry filed for a patent for a new encryption technology that built on the public and private keys that Michael Doyle created. The patent is almost an exact copy of the blockchain technology that Nakamoto would introduce two months later. However, the three men deny any connection to Nakamoto.

The Bitcoin white paper was the product of nearly two decades of advances in the field of cybersecurity, and it built on many pre-existing ideas. The centralized server system is prone to hacking, no matter how intense security protocols may be; banks that use a centralized server set all of their customers at risk of losing money and personal information. Bitcoin is different, it was created by developing an entirely new model of programming and cybersecurity, one which is insusceptible to hacking and data manipulation. Nakamoto set out to create a peer-to-peer virtual currency that would change how money is handled, and in the process also created a programming model that would change the paradigm of system security.

​Just as the blockchain technology that underlies Bitcoin, it was not created in isolation, the Bitcoin revolution did not happen overnight but took several years and failures. On January 3, 2009, Bitcoin was officially launched when Nakamoto mined the “genesis block” (for more information on mining, see Chapter 4; for more information on what a block is, see Chapter 2). It was not a public moment that led to standing ovations; at least, not at first. In fact, for several years, Bitcoin was little more than a side interest of the technophile community. However, members of that community developed an interest in the concept of blockchain and Bitcoin and helped lay the foundation for its development as an economic revolution. ​

On October 5, 2009 — over a year and a half after it was initially released — a user known as New Liberty Standard published an exchange rate for Bitcoin: 1.309.03 BTC per dollar, or about .08 cents each. This rate was not based on how much in demand the virtual currency was because up until this point, it had never even been used as a monetary currency. Rather, it was based on how much electricity was required to mine one Bitcoin.

The year 2010 saw Bitcoin begin to show its viability in the commercial sector. In May of that year, Laszlo Hanyecz offered 10,000 Bitcoins to anyone who would order him two large pizzas. A user known as jercos took him up on that offer and ordered the pizzas from Papa Johns. This event marked the first time that Bitcoin was used in a commercial transaction. That summer, Bitcoin 0.3 was published on the technophile news website www.slashdot.com, which caused a surge of popularity. A man named Jed McCaleb grabbed onto the concept and established a Bitcoin wallet, which would come to be known as Mt. Gox. Mt. Gox would become a financial giant before collapsing in a scandal that would threaten to sink the entire concept of cryptocurrency. By the end of 2010, the total value of all Bitcoins in circulation would exceed one million dollars.

 ​However, not all was good news. That same year, an international watchdog known as the Financial Action Task Force issued a warning for virtual currencies. The anonymity associated with them, as opposed to the verification processes required by many banks could be exploited to support illicit activities such as money laundering and terrorism. Sadly, that prediction would soon prove to be true. On January 27, 2011, Ross Ulbricht created a website known as Silk Road, an illicit website named after the ancient trade route that connected China to the West. His goal was to use Bitcoin’s anonymity to enable people to purchase illegal drugs online.

In the third quarter of 2010, a Bitcoin user suggested that because of its anonymity, Bitcoin is used to fund the controversial WikiLeaks page. PayPal, MasterCard, Discover, Visa, and other major payment processors had made contributions to WikiLeaks using their accounts impossible, so Bitcoin seemed to be the perfection option. However, on December 5, Satoshi Nakamoto stated that he did not wish to take a political stance because assessing controversial situations such as WikiLeaks was not the best way to grow the currency. A week later, he made his final appearance in the Bitcoin community before the pseudonym disappeared altogether. Despite his admonitions, Bitcoin enthusiasts used the currency to contribute tens of thousands of dollars to WikiLeaks. ​

With Nakamoto no longer a part of the Bitcoin community (other than his massive Bitcoin holdings), it lacked a visionary leader to guide it. While Bitcoin was created to be decentralized rather than function around any galvanizing force, Nakamoto’s vision had been an essential part of moving forward the virtual currency movement. The year 2011 would see the ramifications of his absence, as Bitcoin scandals began to erupt. Most notably was the Silk Road website, but Bitcoin was also used by so-called entrepreneurs to engage in money laundering.

Bitcoin grew considerably during 2011. In February, it reached parity with the US dollar, meaning that one Bitcoin was worth one dollar. The next month, Britcoin was established to facilitate trade between Bitcoins and British pounds, and an exchange opened in Brazil to facilitate trade between Bitcoins and Brazilian reals. By April, Bitcoins could be exchanged with Eurodollars and had parity with the pound sterling and Euro.

On April 16, 2011, edition of Time Magazine featured an article by journalist Jerry Brito entitled “Online Cash Bitcoin Could Challenge Government, Banks.” It was the first time that Bitcoin was featured in a mainstream news outlet and led to such a high surge in its popularity that by the summer, one Bitcoin was worth ten dollars. ​

That same summer, Mt. Gox was hacked; the hacker transferred to himself a large number of Bitcoins that did not exist, and the value of one Bitcoin was falsely lowered to one cent. Mt. Gox and other exchanges quickly responded with tighter security measures. This event revealed that while Bitcoin itself was impregnable, the exchanges that facilitated its use were not. Another event would soon unfold that would show that even though the US government does not regulate Bitcoin, it will prosecute people who use it to engage in money laundering.

In August of 2011, so-called entrepreneurs Charlie Shrem and Gareth Nelson created a startup called BitInstant. BitInstant claimed that it was able to enact high-speed transactions, which would otherwise take an hour or more to process. In 2014, the company was found to be engaging in money laundering, and the FBI got involved in the prosecution. In November of 2011, Trendon Shavers opened the Bitcoin Savings and Trust, which promised high-yield investments of 7%, meaning that in addition to the rapidly increasing value of Bitcoin’s exchange value, the number of Bitcoins that an investor-owned would double every ten weeks. This company was revealed to be a Ponzi scheme, and investors were defrauded out of 700,000, with total damages estimated at $40 million. Events such as these threatened to derail the entire Bitcoin movement.

Nevertheless, it continued to gain steam with the public and the commercial sector. In November of 2013, a research article came out which showed that while in the early years of Bitcoin, the currency was used for illicit "sin activities," it is now a legitimate currency that is mainly used for commercial purchases of everyday goods. More and more retailers began accepting payments in Bitcoins, and in November 2013, the University of Nicosia in Cyprus started accepting Bitcoins as payment for tuition. They could even be used for large purchases, such as a house or car.

Another tragedy erupted in early 2014 that once again, threatened to derail Bitcoin completely. Mt. Gox, now the largest Bitcoin exchange in the world began bankruptcy proceedings. It was now insolvent because a theft that occurred in 2011 had led to the loss of over 700, 00 Bitcoins. Many investors lost thousands of dollars’ worth of Bitcoins, and total losses were estimated to be half a billion dollars.

Over the next few years, as the Bitcoin movement continued to grow with increasing force, governments began making moves to try to regulate the cryptocurrency. New York State required companies to get an expensive BitLicense before they could accept payments in Bitcoins, and the IRS issued a statement that Bitcoins were considered assets, a move that could lead to taxes on them. The government of Japan allowed for payments in Bitcoins to the government, and the currency began to be accepted by UK banks such as Barclays. While the latter moves look like openings for Bitcoins to be accepted more in the mainstream, some are concerned that they are underhanded attempts at regulation.

Despite numerous setbacks, the Bitcoin community has continued to grow, continually defying the predictions set by mainstream economists and politicians. As a movement, it shows no signs of stopping.

How to Get Your First Bitcoins ​

Whatever your reasons for wanting to become involved in the Bitcoin movement, the decision is one that you are not likely to regret. Its growth cannot be matched by any mainstream investments, and while you may not become a millionaire overnight (but hey, you could), if you are willing to ride out the ups and downs of virtual currency, you stand a very good chance of watching your money grow.

There are several different ways to get your first Bitcoin. Before you can do so, you will need a Bitcoin wallet (for more information on Bitcoin wallets, see Chapter 5), which makes you a part of the Bitcoin blockchain so that you can send and receive Bitcoins.

One way to get your first Bitcoins is to request to be paid in Bitcoins. If a friend or family member wants to send you money for your birthday, graduation, or other special occasions, ask that they sent it to you in Bitcoins rather than in dollars or another national currency. If you own an online business, you can enable customers to pay with Bitcoins. BitPay is a tool that will allow you to do this. To get started with BitPay, go to www.bitpay.com. You will need to have a Bitcoin wallet already so that you can connect it to the BitPay tool. The website will guide you through the simple process of enabling Bitcoin-based payments on your website.

Another way to get your first Bitcoin is to buy them through an exchange. There are many Bitcoin exchanges, and they each come with their own benefits and drawbacks. LocalBitCoins is an exchange that allows users in the same geographical area to arrange a time and place to meet so that they can exchange Bitcoins in person. Kraken and CoinMama are just a couple of online exchanges through which you can buy Bitcoins with dollars or other national currencies. While secure, exchanges can have very high fees, so make sure that you are aware of the fees before you make your purchase.

Sending and Receiving Bitcoin ​

Sending and receiving Bitcoins is a relatively simple, easy process. There are two ways in which you can send Bitcoins. One is if you already have the Bitcoins in your wallet, and the second is if you don’t. Either way, you will need to know the public key for the person to whom you are sending the Bitcoins (for more information on public keys, see Chapter 2). If you already have the Bitcoins in your wallet, you will simply go to your wallet and select the option in the menu that allows you to send Bitcoins. You will then be prompted to enter the amount that you want to send and the public key specifying where they will be sent. Once you complete the transaction, the blockchain will take from about 10 minutes to one hour to verify it. Once it is verified, the other person will receive an email with the Bitcoins. If you do not already have the Bitcoins in your wallet, you will need to purchase them as part of the sending process. Go to your wallet and select the option in the menu that allows you to send Bitcoins. You will need to enter the amount and the public key, as well as the payment information that you will be using to pay for the Bitcoins. The blockchain will need to verify both your purchase of the Bitcoins and the sending of them to the other person, so the transaction may take up to two hours to process. Once it is fully processed, the other person will receive an email saying that you sent him or her Bitcoins.

Mastering Bitcoin for Beginners - Neil Hoffman